Welcome to the Ten-Year Slog

First read the excerpt on “How Short Selling Works” that guys over at The Awl pulled out.:

“Short-selling is on the decent-sized list of practices which seem bizarre to civilians but to insiders are a routine feature of how modern markets work. A short-seller borrows shares in a company, and then sells them, with the intention of buying them back at a cheaper price, returning them to the lender, and trousering the profit. Say you decide that, to take one purely hypothetical example, News Corp is overvalued because – oh, I don’t know, just to make something up – because all its senior management are going to go to jail. The current price is $15.80 and you reckon it’s heading for ten bucks. So you find a willing lender, borrow one million shares with an agreement to return them on a specific date, and then you sell them. Notice that this selling is not a neutral event: by dumping $15.8 million of News Corp stock you actively help to drive prices down. Critics of short-selling point out that this shades into a form of market manipulation, which is illegal. A short-seller isn’t just betting on an outcome, he (it’s usually a he) is trying to bring it about. Anyway, some months pass, the News Corp execs are charged with multiple malfeasances, the stock tanks to $10, you buy back the million shares – this is called ‘covering the short’ – and give them back to the lender.”

But if you read the full piece from John Lanchester in the London Review of Books – and you should – you’ll notice among many things the wonderful footnote that extends the description of short selling with an example of it can go wrong:

I make this ‘covering’ sound routine, but it isn’t, and can go horribly wrong – wherein lies much of the risk in shorting shares. In 2005, Porsche began to buy shares in Volkswagen (I know that sounds the wrong way around), to help it ward off a foreign takeover. They kept buying shares over the next three years, and as they did so the share price rose. As it did so, the remaining Volkswagen shares, obviously, kept becoming more expensive, so it became clear that Porsche wouldn’t be able to afford to buy all the rest of them and take full control of the target company. At the same time, prospects weakened for the global car industry. The hedge funders took out their crystal balls and concluded that this meant Porsche would stop buying shares, and so the share price would fall, and they began to short Volkswagen stock. So far, so routine. But what they didn’t know was that Porsche was secretly using Germany’s not so transparent rules to accumulate more and more shares, until 26 October 2008, when Porsche announced that it now owned 75 per cent of Volkswagen, i.e. pretty much all the publicly tradeable stock – most of the rest was, for various reasons, locked up in places where it couldn’t be sold. At which point, the hedge funds shat themselves. Remember, all those shorted shares were borrowed, and had to be bought back and then returned – but where were the hedge funds going to buy the shares to return them, since there was now no stock on the market? Answer: they’d have to pay whatever the seller wanted to charge. In 48 hours, Volkswagen’s share price went from €200 to more than €1000. Hedge funds lost £24 billion betting against Volkswagen and Germany’s fifth richest man, Adolf Merckle (b. 1934, cement, pharmaceuticals), threw himself under a train.

Short selling aside, Lanchester depicts the downward spiral that we are headed down better than any one I have read yet. And yes, this is a downward spiral. As he notes near the end, “It’s starting to look as if the best-case scenario for the aftermath of the crash is already dead.”

It is time to break out all the advice columns and top 10 tips for living through and surviving depressing the depressing times ahead. The worst is not behind us.